February 16, 2014

Legal Theory Lexicon: Property Rules & Liability Rules

Introduction

One of the most famous distinctions in contemporary legal theory was made popular by Guido Calabresi & A. Douglas Melamed s famous article, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral. The core idea is simple. Legal rules that create private causes of actions (or claims for relief) can be sorted into two kinds. Kind one consists of rules that entitle the claimant to an injunction. Kind two consists of rules that entitle the claimant to damages. The first kind of rule is associated with property rights--hence, we can call the first kind "property rules." The second kind of rule is associated with tort liability or contractual liability--hence, we can call the second kind "liability rules. The distinction between property rules and liability rules is important, because injunctions and damages have different effects on future behavior and on negotiated settlements to claims.

This post in the Legal Theory Lexicon Series is aimed at law students--especially first-year law students--with an interest in legal theory. As always, this is a very short introduction to a complex topic. I've provided references for further reading and a deeper understanding.

Calabresi & Melamed's Famous Formulation

"Another View of the Cathedral" is one of those articles that every law student should read. But to get us started, let's quote the famous passages from near the start of the article where the distinction between property rules and liability rules is introduced:

An entitlement is protected by a property rule to the extent that someone who wishes to remove the entitlement from its holder must buy it from him in a voluntary transaction in which the value of the entitlement is agreed upon by the seller. It is the form of entitlement which gives rise to the least amount of state intervention: once the original entitlement is decided upon, the state does not try to decide its value. It lets each of the parties say how much the entitlement is worth to him, and gives the seller a veto if the buyer does not offer enough. Property rules involve a collective decision as to who is to be given an initial entitlement but not as to the value of the entitlement.

Whenever someone may destroy the initial entitlement if he is willing to pay an objectively determined value for it, an entitlement is protected by a liability rule. This value may be what it is thought the original holder of the entitlement would have sold it for. But the holder's complaint that he would have demanded more will not avail him once the objectively determined value is set. Obviously, liability rules involve an additional stage of state intervention: not only are entitlements protected, but their transfer or destruction is allowed on the basis of a value determined by some organ of the state rather than by the parties themselves. An entitlement is inalienable to the extent that its transfer is not permitted between a willing buyer and a willing seller. The state intervenes not only to determine who is initially entitled and to determine the compensation that must be paid if the entitlement is taken or destroyed, but also to forbid its sale under some or all circumstances. Inalienability rules are thus quite different from property and liability rules. Unlike those rules, rules of inalienability not only "protect" the entitlement; they may also be viewed as limiting or regulating the grant of the entitlement itself.

There is a lot packed into this short package. First, we get the basic distinction between enforcement by injunction and enforcement by liability for damages. Second, we get the distinction between rights that are alienable and those which cannot be bought and sold and hence are "inalienable." Third, we get an argument that alienable rights that can be enforced by injunctions require less state intervention than do inalienable rights that are only enforceable by damage awards. These three ideas were the conceptual core of Calabresi and Melamed's distinction between property rules and liability rules.

Mixed Rules

Even if you have never encountered the distinction between property rules and liability rules before, you probably have already thought to yourself that the world is not quite as black and white as the distinction implies. The same underlying "primary right"--such as the right to security of property--may be enforced by both injunction and damages and involve both alienable and inalienable aspects. That is, there are "mixed rules" as Calabresi and Melamed themselves noted:

It should be clear that most entitlements to most goods are mixed. Taney's house may be protected by a property rule in situations where Marshall wishes to purchase it, by a liability rule where the government decides to take it by eminent domain, and by a rule of inalienability in situations where Taney is drunk or incompetent.

Choosing Between Property Rules and Liability Rules

Why should the law choose property rules for some situations and liability rules for others? That's a very large and complex question. Here are some of considerations that bear on an answer--recognizing that these are only starting points:

The Possibility of Bargaining--It might be argued that property rules are better suited to situations where the parties can bargain over the transfer of rights. So the possessory interest in real estate or chattels might be protected by property rights, because the transfer of possession is something over which the parties can bargain. An injunction against involuntary transfer forces the parties to agree on terms for a voluntary transfer. On the other hand, it might be argued that liability rules are better suited to situations in which bargaining is impossible (or to be more precise, very costly). For example, it would be difficult to bargain over an automobile accident--the parties may be strangers, the accident is unanticipated, and so forth. In that situation, a damage award rather than an injunction seems like the only feasible mechanism for protecting the right.

Existence or Measurement of Damages--Sometimes it is very difficult to measure damages. For example, in copyright law, it may be difficult to prove that my copying of portions of you book had the consequence of hurting your sales. (It's possible my copying even helped your sales.) When damages either don't exist or can't be measured, then liability rules may be ineffective. But if the copyright holder--to continue the example--has the right to an injunction, this will force the infringer to pay for the right to continue the infringing activity.

Administrative Costs--Liability rules require the system to measure damages and that may be costly. Evidence on the extent of damages must be gathered, processed, and evaluated by a finder of fact. Property rules do not involve these costs. This facto generally favors property rules over liability rules.

Of course, this is a partial and incomplete list. But these examples illustrate the kinds of considerations that might favor a property rule or a liability rule as the solution to a particular legal problem.

Conclusion

The distinction between property rules and liability rules is fundamental to private law. As you study contracts, torts, and property, it is very useful to ask yourself whether a particular legal doctrine or cause of action involves a liability rule, a property rule, or a mixed rule. Once you have the answer to that question, the next inquiry is "why?" What justifications can be offered for the law's choice of a property rule over a liability rule, or vice versa. If you ask these questions systematically in your study of private law, you will be well on your way to a deeper and more sophisticated understanding of these building block subjects.